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Updated on Friday, April 24, 2020
Managing your 401(k) during a recession might sound like an intimidating task — but it has become the reality for many Americans as the coronavirus pandemic continues to batter the economy. With the help of a $2 trillion relief package passed by Congress, coupled with a strategic and steady approach to investing for your future, you can make sure your 401(k) weathers this economic storm.
- Do prioritize having an emergency savings fund
- Don’t stop contributing to your 401(k)
- Do check in on your asset allocation
- Don’t withdraw your 401(k) funds if you don’t have to
- Do consider skipping your required minimum distribution for 2020
- Don’t overlook how the CARES Act can help you as a last resort
Do prioritize having an emergency savings fund
In times of economic upheaval, an emergency savings fund is an absolute essential. So before you make the balance in your retirement portfolio a top priority, ensure that you have a solid emergency savings fund with enough money to cover three to nine months’ worth of expenses. Your retirement fund should not double as your emergency fund — instead, that fund should be a separate, liquid savings account.
“While in an ideal world you’d invest as much as possible during a down market to take advantage of inexpensive stock funds, it’s more important during a down market to make sure you have liquidity outside of your retirement plan,” said David Shotwell, a certified financial planner (CFP) in Lansing, Mich. “Keep in mind that the economic difficulties that cause market upheavals can also cause job losses and other liquidity concerns, so consider your situation before you pile all your extra cash into your 401(k).”
Don’t stop contributing to your 401(k)
Once you’ve established a solid emergency fund, keep on chugging along with your 401(k) contributions.
The wild market swings might make peeking at your portfolio painful, but experts recommend sitting tight. Your portfolio should be designed to weather such economic storms, and if you raid your account when the market’s down, you’re stuck with those losses and will miss out on any gains when the market eventually recovers.
“The same principles hold true during a down market as an up market — you should have an intentionally-built portfolio geared toward your age and how much market volatility you can stand,” said Shotwell.
That might mean continuing to make systematic contributions at regular intervals — a smart investing strategy known as dollar-cost averaging — and making sure you’re taking full advantage of any employer match offered by your place of employment.
Do check in on your asset allocation
During a market downturn, it isn’t a bad idea to take a peek at your portfolio and reassess your 401(k) asset allocation. Younger investors don’t have as much cause for concern, as they have a longer time horizon to ride out the highs and lows of the stock market. However, older investors who are nearing or in retirement might understandably feel a bit more spooked.
If you find yourself in the camp of being close to your golden years, many financial experts recommend shifting some of your riskier assets — like stocks — to safer investments, such as bonds. Shotwell, for example, recommends that if you’re 30 years out from retirement, your asset allocation should be mostly stock funds, while older investors who are closer to retirement should reduce their risk by adding bond funds to the mix.
“The proper amount depends on how much of your account you will need each year when retirement starts,” Shotwell said, adding that a typical portfolio for someone who is a year or two out from retirement might be 40% or 50% in bonds.
“If you’re close to retirement and still too heavy in stock funds, it might be best to ride out the downturn and reduce risk after the market recovers,” he advised.
Don’t withdraw your 401(k) funds if you don’t have to
While the Coronavirus Aid, Relief and Economic Security Act (CARES) makes it easier for you to access your retirement funds — which we discuss later in this article — you should not raid your 401(k) if you do not have to. This might be easier said than done; in fact, in a recent survey, we found that most people can’t stomach even a 10% decline in the market.
However, if you withdraw your retirement funds out of panic when you see your portfolio balance plummeting, you are actually unraveling years of hard work, as you will be locking in your investment losses, instead of allowing them to rebound when the market eventually recovers. This just further underscores the importance of having an emergency savings fund outside of your retirement account.
Do consider skipping your required minimum distribution for 2020
Thanks to the coronavirus relief act, there will be no required minimum distributions (RMD) for IRAs or workplace retirement plans, such as 401(k) plans, for 2020. Typically, for many retirement accounts, you are required to start taking withdrawals at the age of 70 ½.
However, the CARES Act removes that requirement for the year of 2020, meaning you won’t be forced to cash out on investments that sunk significantly in value amid the coronavirus pandemic, and instead gives those investments time to recover.
Now’s the time to carefully consider whether you can afford to waive your required minimum distribution for 2020. This could be a good idea, as the coronavirus pandemic has left mandatory distributions looking bleak amid the current market rout. You can find more information about the required minimum distribution waiver for 2020 here.
Don’t overlook how the CARES Act can help you as a last resort
In a nutshell, the rescue package makes it easier and less expensive for Americans to access the funds in their retirement accounts during the pandemic. In the case you find yourself unemployed and unable to meet your basic needs — like having shelter and food — raiding your retirement account might feel like your last resort.
This is where the CARES Act can help: It waives early withdrawal penalties for withdrawals up to $100,000 from qualified retirement plans and IRAs. Typically, retirement plans slap a hefty 10% tax penalty if you withdraw your funds before you are 59 ½ years old. However, the IRS is waiving that penalty for coronavirus-related reasons.
The CARES Act also provides investors with other special tax benefits if they need them. This includes waiving the 20% mandatory federal income tax withholding that many retirement plans require and instead, allowing you to pay back any federal income tax you owe on your withdrawals over a three-year period. The bill also doubles the amount you’re able to borrow from your retirement plan.
While withdrawing from your retirement account early and borrowing from it aren’t the first financial moves you should make, many Americans are finding themselves crippled by the economic destruction caused by the pandemic. If you find yourself struggling, the CARES Act can help alleviate the financial burden that comes with tapping into your retirement accounts early.
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